SHANGHAI -- China has stepped in to halt the yuan's sharp depreciation, but authorities must walk a fine line as a weak home currency may prove Beijing's last resort in the trade war with the U.S.
The People's Bank of China on Monday imposed a 20% reserve requirement on certain foreign exchange forward contracts, essentially making it more expensive to short the yuan. The mandate, announced Friday night, is ostensibly to hedge against risk, but the market sees the real objective as "reining in speculators becoming active at home and abroad," in the words of a trader at a second-tier Chinese bank.
The PBOC employed the same mechanism soon after devaluing the yuan in August 2015, and abandoned it last September. Since trade frictions with the U.S. intensified in April, China had allowed a gradual decline by the yuan as it made Chinese exports more competitive.
But the decline has picked up pace of late. The currency has dropped 9% from the March-April high of 6.27 to its current level.
Alarmed that too steep a fall could trigger capital flight, the PBOC has resorted to frequent yuan-buying interventions since late July.
The yuan was trading at 6.9 to the dollar just before closing Friday when it suddenly appreciated to 6.86 at 4:09 p.m. "There is no doubt that they [the central bank] intervened to prompt up the yuan," said a foreign exchange dealer for a bank based in Shanghai.
Market interventions, however, give speculators an opening. "Frequent interventions are ideal earning opportunities," said a source at a Hong Kong asset management company. The PBOC found it necessary to rein in the short-sellers with the latest measure, and also to placate U.S. President Donald Trump, who is accusing Beijing of deliberately depreciating the yuan.
On the other hand, the bank set the yuan reference rate to 6.851 per dollar early Monday, the cheapest level since May 2017. The move indicates that Beijing is not pushing for a stronger national currency. At the end of Monday's general trading, the yuan stood at 6.84, a successful outcome for the PBOC.
But few market watchers believe the yuan will remain stable for the medium to long term. The Chinese economy is trending slower, with 10-year interest rates dropping more than 0.5 point from the beginning of the year. China's benchmark yields now hover below 3.5%, reducing the spread against 10-year U.S. Treasury yields, which have been flirting with 3%. China's earning potential is also open to concern. The country incurred a $28.3 billion current account deficit for the first half of the year, according to state figures released Monday. The expanding deficit in services, such as tourism, was the main culprit, but the number still could sow doubts in China's ability to generate income.
"China is quickly losing options in its trade war with the U.S., so it will have no choice but to rely on the weak yuan in the end," said a source at an international bank. The Shanghai Composite Index plumbed a fresh year-to-date low of 2,705 points Monday and is approaching the 2,655 valley struck in early 2016.
The yuan shock that undermined Chinese equities was set off by the PBOC's devaluation in 2015, three years ago this coming Saturday. Although China under President Xi Jinping aims to make the yuan a global currency, the path to reach that goal is still fraught as authorities struggle to stabilize the currency.